We like the prospects for CBS a lot right now. Television, in the local broadcast sense, seems somewhat stagnant. The thirst, though, for original content as the digital battle occurs is allowing CBS to drive profits and growth. The company ended in the 2012-2013 TV season with 12/25 top shows on TV and has tons of potential as many of those shows are young and creating following. Additionally, the company should see another big capital injection from Outdoor Americas going public next year.
Value is solid in CBS. We label the company as "mid-growth," so we need to see some value as well in shares to get involved, as the company does not offer enough growth to be able to sustain wildly high valuations. At current levels, we believe CBS is attractive. For growth stocks, we like to buy in the 20-25 PE and 16-18 future PE. Mid-growth, we like to be at the 18-20 range for PE and 14-16 future PE, so we are seeing a nice opportunity to buy as the short-term issue with Time Warner Cable (TWC) has recently created value.
The company is also cheap when we look at them compared to their PEG at 1.3. What that shows is that the stock is not being overpriced in comparison to earnings growth rate. Why is this? Recent issues with TWC have dropped the stock, but there is also a fear that TV is going through a period of movement to Netflix (NFLX), Amazon Prime (AMZN), and other digital sources. CBS, though, maintains the best content in the marketplace. Their cable shows are strong, and they owned 12/25 top shows overall by viewership. The company can, therefore, get large deals for their shows on digital sources to license them.
One area of improvement is their dividend yield. The company is only at 0.9%, which is not as strong as we would expect for the company's cash flow generation and size. The positive, though, is that the stock is very cheap in comparison to their cash flow. They are priced at only 19x OCF, which means that the company can see a lot of multiple increases, as OCF/FCF is strong. Moves like share repurchases, dividend increases, and acquisitions can be expected with strong cash flow generation, and the company will see upside movement on these moves.
Overall, value attracts us to CBS as a mid-growth name with quite solid value overall. The company is expected to expand margins over the next couple years as well, which will only make these valuations look even cheaper.
Growth is fairly solid for CBS. We see them as having quite a few positive momentum factors to create a lot of upside for the rest of 2013 and through 2014. The company has the best content in the media space, and that is their #1 calling card. With top-notch content, they will be able to command great deals with NFLX, AMZN, and others. The company is going to see earnings injections from their Outdoor Americas IPO in 2014, and the company is expanding offerings in sports, film, and is about to go through a political year in 2014. We talk more about growth prospects in the Catalyst section.
The company is expecting to see a lot of earnings growth over the next two years as they see margin expansion due to operating expenses coming down and the company improves margins on shows as they license original content and are focusing on creating wholly-owned content that helps to reduce operating expenses. Operating expenses have dropped every year since 2008.
The company, additionally, is focused on strong ROIC growth, which we believe is a key to CBS' strategy. ROCI has grown 170% in the past five years, grew over 25% from 2011-2012, and it is already up 8% in the TTM versus 2012. The company is improving ROIC as it continues to generate larger net income and has reduced total capital by dropping long-term debt by about 20% over the past five years. The company's large cash flow generation helps to allow them to pay off debt, not add new debt, and keep ROIC/ROE moving up. Additionally, we believe that the growth of earnings and ROIC could take another charge higher due to the company's newest model of financing that arose with Under the Dome over the summer, which we will discuss more in the Profitability and Catalyst sections.
Profits are another strong point for CBS, and despite the neutral score, the key areas are strong. The company maintains strong gross and operating margins with 43% and 21%. We believe these margins will continue to improve as the company sees the ability to create more earnings for each show as costs remain fixed but demand rises.
One of the reasons margins should continue to improve is licensing TV shows. With the top content, NFLX, foreign markets, AMZN, and secondary markets will pay top dollar for shows that command millions of viewers. Retrans deals also will be strong as the company can get cable networks and local broadcasters to pay more for their shows. Expenses may rise slightly as shows grow in popularity, but they won't outweigh margin expansion.
A prime example of this growing phenomenon is what occurred with CBS' summer show Under the Dome. For the show, Amazon paid upfront for the shows. The company was able to make the show profitable before it even aired by making the show available on Amazon Prime four days after airing. With that, they could pay more to produce the show at $3.5M per episode. The show got 20M viewers per episode, and that also helped them to market for their new series and renewed shows for the fall. Additionally, the company can now get top dollar for advertisers as well, creating tons of profits. The power of content and its interconnectedness with digital subscribers, licensing, and advertising creates tons of profit potential.
The company is growing ROE and ROIC as a result, and we expect those numbers as well as margins to continue to improve. Overall, profits are solid and should be even more solid moving forward.
Cash Flow & Efficiency
Cash flow and efficiency is a weak spot for CBS mostly due to the fact that FCF has dropped over the past five years and efficiency levels are low. Yet, the company's cash flow growth is low due to large returns of cash flow to investors and efficiency ratings are low due to the makeup of the industry.
We like to see positive cash flow generation. For us, it shows a company that has the ability to manage expenses well, not extend themselves in interest payments, and can increase dividends and share repurchases. CBS has just extended their share repurchase program by $6B, and we will look for the company to continue these initiatives moving forward.
As far as efficiency, the company appears weak with DSO over 76, days in inventory at 21, and a CCC at 86. Days in inventory are not weak, but it takes a long time to get sales filled and turn them into cash. Yet, how does this compare to competition?
Let's look at Twenty-First Century Fox (FOXA), Disney (DIS), Sinclair (SBGI), and Scripps Network (SNI). FOXA has DSO at 80, DIO at 56 and CCC at 70.5. DIS sits at 51.6, 15.4, and 18.2, but they are a bit different. SBGI DSO at 57, and SNI have DSO at 91. We can see that CBS has a DSO similar to competition and even better than some competitors. They are strong in DIO and CCC is weak. The company is so-so in efficiency, but we buy TV companies for content, profits, and growth rather than efficiency.
Cash flow is a plus, but we would like to see more growth to improve their dividends. Efficiency is so-so but more of an industry issue.
Financial health is fine for CBS. Here we are typically looking for any major red flags. We see a decent enough current ratio at 1.3. We tend to want to see that at 1.5, but 1.0 and above is acceptable. Quick ratio is also just decent at 0.9. The company has as many current liabilities as assets. The company can cover those liabilities 1.5x with gross profits, which is enough for us as well. They are weak, though, in several areas.
Once again, the company's cash does not amount to enough to cover current liabilities or total liabilities as we can see. CBS devotes a lot of cash to building up share repurchases and some dividends, but in comparison to the size of the company's liabilities, we would like to see them hold more cash on hand. Another area of weakness is the company's financial leverage at 2.1.
The company has a strong debt-to-equity profile, and the company has reduced debt by about 20% in the past five years, which shows a continued importance on working off debt levels. The company has an interest coverage ratio of 8.2, which is once again fairly solid. We look for strength over 10, though, so they are just meeting the levels we like.
With CBS, we believe they have strong enough financial health to be an investment, but they could use improvement.
CBS has a number of terrific catalysts that we believe will allow this stock to increase in value quite significantly. We believe shares have 15-20% upside in the next six months and 25-30% upside in the next eighteen. The company has a ton of positives without a lot of negatives. The company's ability to grow starts and stops with its content, and so that is the important place to start any conversation about CBS. Further, the company should see quite a bit of benefit from their Outdoor Americas unit going public as well.
In the past TV season, CBS had twelve of the top 25 shows by viewership. Those shows included NCIS (21.6M per show), Big Bang Theory (19M), NCIS: LA (17.5M), Person of Interest (16.2M), Two And A Half Men (13.9M), Blue Bloods (13.3M), Elementary (13M), Criminal Minds (12.6M), 60 Minutes (12.4M), Vegas (12.0M), Survivor (11.9M), and CSI (11.9M). The company had the top show on TV, the top comedy on TV, the top new series, and even the top freshmen series. As far as cable goes, the company has hits on Showtime with Dexter and Homeland. Both shows are in the top ten of most watched cable shows, and given their smaller viewership are prime candidates to attract digital TV deals.
The key for CBS is that the company produces the top content and has moved to wholly owning most of their content. What that means for them is that they can license their content to companies like NFLX, AMZN, overseas companies, cable networks for reruns, and more. These deals are gigantic. For example, the Under the Dome deal, previously mentioned, garnered over $45M from AMZN and international markets. These types of deals help to add tons of value for the company. We believe that more players in the digital and Internet-streaming means bids will go up, and the companies with the best content can garner the largest bids. With CBS being the top dog, the company has a lot of power to make money in this arena, and we foresee them continuing to benefit from the NFLX, AMZN growth. Additionally, these deals garner interest for the company to have more popularity once the show does air live again. For shows that have ended, it also helps to allow them to continue to create earnings after they have already been retired.
Some issues that most critics highlight about TV is that there is a move towards cable and programming is losing ad revenue. For CBS, though, the company makes a lot of their money off of retrains for companies like Sinclair to stream their TV shows on their CBS affiliates. While there is some effect to the downside, the company has the top shows that attract the most users, so negative effects have not been seen. In fact, the company highlighted that retrans was a positive for them for growth. Further, the company continues to develop a lot of revenue from outside advertising. In the latest quarter, the company saw non-advertising revenue at 43% versus 30% just a couple years ago. We believe that CBS is well in front of the shifting season and is actually leading to create new business plans.
The growth and catalysts continue for CBS this fall. The company returns 20 shows and only adds five new shows. That is a big win for CBS because it means that they can continue to see a lot of success on winning shows and not worry about having to impress with a lot of new shows. The company has noted that they have already seen solid advertising revenue growth for the upfront market and are leading their competition in both volume and pricing. Advertising remains strong, and the company is seeing the growth of new revenue streams.
What's great is that advertising is growing in revenue, so for non-advertising revenue to be a larger share of the company's overall revenue makeup, it means that there is a lot of organic growth going on for the company. Streaming will continue to create growth for the company. They have a lucrative deal with Netflix through 2015 and a deal with Amazon in Germany and UK. In 2015, we will likely see another major deal worth even more money as AMZN, NFLX, and potentially other services fight for CBS shows and content. The actual numbers on those deals are hush-hush, but the first deal in 2011 was expected to be $200M. The last deal was thought to be worth a similar level, potentially $240M-$250M. These deals are providing tremendous margin expansion for the company as the costs are minimal for CBS and it allows them to take shows like Twin Peaks and Star Trek and continue to make money from them. What more, as the internet continues to grow in other nations, it will provide lots more upside for the company to get more deals in Asian nations, grow deals in Europe, and so on.
Another major positive moving forward for CBS that we believe creates tremendous value for them is the IPO of CBS Outdoors America. When companies break off divisions, it allows them to focus in on those divisions more and actually will make the company's growth and margins stronger since CBS Outdoors has lagged cable and TV. The company, though, additionally stands to make a hefty sum of money as they take the company public and will likely get a number of shares of the new company. That IPO is expected in Q1FY14. In our model, we show growth still in 2014 even as the break off of Outdoors will hurt comps. We believe TV and cable will be strong enough to allow for a lot of growth, and their payoff from Outdoors should supplement some of that issue.
Finally, we believe that some of the smaller items for CBS are also going to be winners. The company's website is #1 for TV networks (no surprise there) and had 35% growth year/year. The company, additionally, saw mobile ad revenue growth at 96% growth. Mobile ads have been very beneficial to companies like Facebook (FB), and if the company can figure out a way to monetize mobile ads further, it will go a long way. Mobile ads will never be a major win for the company, but mobile streaming is interesting as a potential winner. The company bought a minority stake in Syncbak, which is similar to threatening competitor Aereo. TV stations, though, have to agree to use Syncbak. This could help CBS to battle the Internet streaming sites and monetize it with ads.
Now, we get to the real issue for CBS - the company's situation with Aereo, Time Warner, and so on. The issue is that Aereo is basically stealing the airwaves for CBS. CBS is upset because their ability to get licensing fees from satellite and cable operators to show their service will hurt their business. Companies could take on the Aereo model even and expand the service. Further, it hurts their ability to license content to Netflix, Amazon, and others if Aereo becomes more successful. We believe that the issue is getting ahead of itself. So far, Aereo has not had any issues with legal issues, but at some point, the issue could be very important because CBS could end up moving to cable and/or the makeup of broadcast TV could completely disintegrate, which would end up disintegrating Aereo in the process. It's the sort of biting the hand that feeds issue that never ends up well for the biter. Aereo can't stream cable TV, and also CBS has shown with moves like what happened with Under the Dome that they could find other ways to make money. Aereo can only stream live TV as well, so that tends to not challenge the continuation of AMZN and NFLX licensing. Forever, you can get CBS for free with a pair of rabbit ears, and while Aereo presents a new challenge, we believe that at the end of the day content is king.
The fallout of Aereo, though, is that CBS now wants more for broadcasting on places like Time Warner Cable to be included in their package. CBS wants to get more lucrative licensing deals as a result of Aereo and their dominance. We look at this snafu as an opportunity. TWC is not going to go into the fall season without CBS, and CBS is not going to go into the fall without 5-10% of their potential viewers. Right now, it's fine because there is not a lot of original programming. Even football has not started. We see the issue as transient and believe something can get done here.
In our model, we have priced in about 10-12% growth in operating income for the next two years as we see a lot of licensing deals as well as continued dominance of content. Additionally 2014 is a politics year. 2015 may see a slowdown, but we see 2016 roaring back up again for another major election year. TV continues to be king, and CBS is the best in the business.
Price Target Analysis
Project operating income, taxes, depreciation, capex, and working capital for five years. Calculate cash flow available by taking operating income - taxes + depreciation - capital expenditures - working capital.
Available Cash Flow
Calculate present value of available cash flow (PV factor of WACC * available cash flow). You can calculate WACC, but we have given this number to you. The PV factor of WACC is calculated by taking 1 / [(1 + WACC)^# of FY years away from current]. For example, 2016 would be 1 / [(1 + WACC)^4 (2016-2012). WACC for CBS: 10.00%
PV Factor of WACC
PV of Available Cash Flow
For the fifth year, we calculate a residual calculation. Taking the fifth year available cash flow and dividing by the cap rate, which is calculated by WACC subtracting out residual growth rate, calculate this number. Companies with high levels of growth have higher residual growth, while companies with lower growth levels have lower residual growth. Cap Rate for CBS: 6.0%
Available Cash Flow
Divided by Cap Rate
Multiply by 20167PV Factor
PV of Residual Value
Calculate Equity Value - add PV of residual value, available cash flow PVs, current cash, and subtract debt:
Sum of Available Cash Flows
PV of Residual Value
Interest Bearing Debt
Divide equity value by shares outstanding:
With the recent issues with Time Warner offering a short-term opportunity for entry, we believe the long-term payoffs are strong at CBS. Owning companies that make their products the most desired are companies that can do well in tough times, create cash flow, and bring the best return to investors. With CBS, we have that and more.